Nato told Russia on Friday to halt its "illegal" military actions in Ukraine after the West accused Moscow of direct involvement in the escalating conflict.

Fears of a wider confrontation have spiralled after Nato said Russia had sent troops to fight in Ukraine and funnelled huge amounts of heavy weaponry to pro-Kremlin rebels in what Kiev described as an invasion.

"This is not an isolated action, but part of a dangerous pattern over many months to destabilise Ukraine as a sovereign nation," Nato chief Anders Fogh Rasmussen said after an emergency meeting of the alliance.

"We urge Russia to cease its illegal military actions, stop its support to armed separatists, and take immediate and verifiable steps towards de-escalation of this grave crisis."

Kiev and the West have accused Russian troops of being behind a lightning counter-offensive that has seen the rebels seize swathes of southeastern territory from government forces, dramatically turning the tide in the four-month conflict.

And in a move certain to anger Kiev's former masters in Moscow, Mr Rasmussen said Nato was not closing the door to Ukraine's possible membership of the alliance after the government said it was taking steps to join.

Russian president Vladimir Putin has repeatedly denied Moscow is fuelling the conflict or having any troops on the ground in the former Soviet state.

And on Friday, he demanded the Ukrainian government hold "substantial" talks with the separatists who took up arms against Kiev in April, apparently emboldened by Russia's annexation of Crimea the month before.

"I believe that what is happening in Ukraine right now is in principle our common colossal tragedy and it is necessary to do everything for it to stop as soon as possible," he said.

Nato on Thursday said Russia had sent at least 1,000 troops to fight alongside the rebels, along with air defence systems, artillery, tanks and armoured vehicles, and had massed 20,000 troops near the border.

The new rebel advance has raised fears that the Kremlin could be seeking to create a land corridor between Russia and Crimea on the Black Black Sea.

Residents of Mariupol, a strategic government-held port on the Azov Sea south of the main insurgent bastion of Donetsk, were fleeing Friday after rebels seized several villages nearby.

The sharp escalation came just days after Nr Putin held talks with Ukraine's president Petro Poroshenko but failed to make any significant breakthrough.

"Russia has deliberately and repeatedly violated the sovereignty and territorial integrity of Ukraine, and the new images of Russian forces inside Ukraine make that plain for the world to see," US president Barack Obama said.

"This ongoing Russian incursion into Ukraine will only bring more costs and consequences for Russia."

Germany warned the crisis was spiralling "out of control", as EU foreign ministers met after talk of more possible punitive measures on Moscow.

The United States and the European Union have already imposed a series of punishing sanctions on Moscow over the worst standoff between Russia and the West since the Cold War.

Poland, which is deeply fearful of Russia, described the situation as a "war".

The latest tensions sent the Russian ruble and the Ukrainian currency nosediving and pushed stock markets down.

But Mr Putin dismissed the concerns and defiantly described the insurgents as defenders of New Russia, a Tsarist-era term for Moscow's former imperial holdings in the region that the strongman has revived since annexing Crimea.

He praised rebel successes in halting Kiev's advances in the counter-offensive in the southeast that has left government troops battling for survival in the town of Ilovaysk.

He called on rebel forces to open a "humanitarian corridor" for the besieged Ukrainian troops.

Top rebel leader Alexander Zakharchenko - who has said the Russian troops in Ukraine were "on holiday" - told Russian television his men would be willing to let government troops withdraw if they give up their weapons.

Ukrainian security chiefs lashed out at the Russian proposal, saying it proved rebels were "controlled directly from the Kremlin".

According to new UN figures, almost 2,600 people have been killed since mid-April, and well over 400,000 have fled their homes, many of them to Russia.

UN chief Ban Ki-moon said the international community had to redouble its efforts to resolve the crisis, and said it was vital general elections in Ukraine go ahead as planned in October.

"Lives are at stake. Peace in Ukraine means peace in the region and beyond," he said.

Kiev said on Thursday that Russian soldiers had seized control of the key border town of Novoazovsk and a string of villages east of Mariupol.

AFP journalists on Thursday saw smoke rising from fighting around Ilovaysk which lies east of Donetsk as fighters demanded government troops surrender or die.

Fighters loyal to Ukraine have been engaged in a desperate fight for survival in the transport hub for over a week.

"Anyone who surrenders and waves the white flag, will not be shot," a rebel fighter called "Klasik" said.